Limited commitment and costly enforcement
A costly 'facility' has a monopoly on the ability to coerce transfers and verify all private information. If invoked, the facility reads instructions recorded ex ante, and carries out the contingent transfers among agents, charging agents for the cost. Agents agree ex ante to a set of recorded instructions to the facility, and then play a sequential game without commitment. A basic two-agent insurance environment serves as an application throughout. When both agents have full information the costs and limitations of the facility constrain the set of attainable allocations, even though the facility is never invoked in equilibrium. When there is private information, the model can be viewed as a reformulation of the standard costly-auditing model, but the incentive constraints are significantly more severe. Pure strategy optimal contracts are debt contracts, as in Townsend (1979), but mixed strategy optimal contracts cannot be ruled out in general. An extension shows that if costs vary with the realized state in a particular way, debt contracts as in Williamson (1987) can be optimal, even allowing for mixed strategies.
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- Lacker, Jeffrey M & Weinberg, John A, 1989.
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- Nahum D. Melumad & Dilip Mookherjee, 1989. "Delegation as Commitment: The Case of Income Tax Audits," RAND Journal of Economics, The RAND Corporation, vol. 20(2), pages 139-163, Summer.
- Steven Shavell, 1980. "Damage Measures for Breach of Contract," Bell Journal of Economics, The RAND Corporation, vol. 11(2), pages 466-490, Autumn.
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- Charles Gross, 1906. "The Court of Piepowder," The Quarterly Journal of Economics, Oxford University Press, vol. 20(2), pages 231-249.
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- Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, vol. 21(2), pages 265-293, October.Full references (including those not matched with items on IDEAS)
- Robert M. Townsend, 1979. "Optimal contracts and competitive markets with costly state verification," Staff Report 45, Federal Reserve Bank of Minneapolis.
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